Texas Tycoon Fights|$3.2 Billion Tax Bill

DALLAS (CN) - Attorneys for the former Texas billionaire Wyly brothers pooh-poohed the IRS' $3.2 billion tax bill on the first day of their bankruptcy trial, denying that the Wylys fraudulently made $550 million by trading stock in offshore trusts.

Sam and Charles Wyly's attorney, Donald Lan with Kroney Morse Lan in Dallas, told U.S. Bankruptcy Judge Barbara J. Houser during opening statements Wednesday that the dispute is merely a "difference of opinion" over tax law.

Assistant U.S. Attorney Cynthia Messersmith, however, said the claims against the Wylys involve "one of the largest tax frauds" in the history of the country.

"This is a case about lies, deception and fraud," Messersmith said. "This is not about tax avoidance, but rather tax evasion. ... It is akin to Monty Python's 'nudge, nudge and wink, wink.'"

Lan disagreed, telling the court that Sam Wyly "is not a tax guy": that he relied on accountants and lawyers to evaluate the offshore accounts and get tax advice.

The Wylys' troubles began in 2010 when the Securities and Exchange Commission sued them in Manhattan Federal Court, accusing them of playing a " global game of hopscotch" by hiding assets in their four companies - Sterling, Michaels, Sterling Commerce, and Scottish Annuity & Life Holdings Ltd. - from 1992 to 2004.

A federal jury concluded in 2014 that Sam Wyly and the estate of his now-deceased brother made $550 million from more than 700 hidden transactions in 40 companies operated by Isle of Man trusts that shuffled money between the Cayman Islands and Dallas.

Sam Wyly and his brother's widow, Carolyn Wyly, filed for Chapter 11 bankruptcy protection several months later in an apparent bid to stave off collection on the judgment.

The IRS intervened in the bankruptcy case in April 2015, telling the court the brothers owe $3.2 billion in back taxes and penalties.

A three-judge panel with the Second Circuit ruled in December that a subsequent asset freeze by U.S. District Judge Shira Scheindlin in Manhattan was proper, but approved freezing the ill-gotten gains of only nine of 16 relief defendants in the SEC case, including family members, heirs, agents and trustees.

Sam Wyly made his fortune co-founding Sterling Software in 1981 and buying an interest in arts-and-crafts retailer Michaels in 1982. Sterling was sold for $4 billion in 2000 and Michaels Stores for $6 billion in 2006.

Messersmith told the court the offshore trusts were designed to evade taxes, and paid out millions of dollars in gifts and loans to family members.

Carolyn Wyly testified for several hours that she had no knowledge of her and her husband's business affairs, nor any knowledge of the offshore trusts. On cross-examination, she acknowledged that she had signed several financial documents over the years, but said she "never asked any questions" because she trusted her husband.

The Wylys' attorneys contend the IRS cannot collect the back taxes and penalties from her if she had no knowledge of the fraud.

Messersmith disagreed, telling the court that Carolyn Wyly "knew enough" about the offshore accounts to ask questions about them.

Sam Wyly testified for 30 minutes at the end of the day and talked about his childhood, his time as an Eagle Scout and his education. He will be back on the witness stand on Thursday. The trial is expected to last four weeks.

Follow @davejourno

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